Macroeconomic Instability of a Capital Markets Union and Stability of a Fiscal Union in the Euro Area: Keynesian and Kaldorian Two-Country Models

In this paper, we investigate the effect of fiscal transfers in a fiscal union in relation to a Capital Markets Union (CMU) for the euro area using Keynesian and Kaldorian two-country models with a monetary union and imperfect capital mobility. We find that an increase in capital mobility between countries in a CMU is a destabilizing factor, whereas an increase in fiscal transfers between such countries is a stabilizing factor. Fiscal transfers mitigate both the instability caused by an austerity policy and an increase in capital mobility in the spending and recipient countries in the fiscal transfer mechanism.